I B d I p l o m a p r o g r a m m eA suite of new resources for the2011 IB Economics SyllabusThe 2011 syllabus changes are going to impact everyone, and we’ve developed

this new edition of our trusted Economics Course Companion to support both

you and your students through the changes.

So what’s new? A brand new CD-ROM packed with extra material, a glossary

to help EAL students focus on the theory, integrated revision support and

thorough preparation for the new quantitative element for HL.

6 ● Costs, revenues, and profit

78

1 M

icro

econ

omic

s

6 ● Costs, revenues, and profit

79

1 Microeconom

ics

Total, average and marginal product

Total product (TP) is the total output that a firm produces, using its

fixed and variable factors in a given time period. As we have already

said, output in the short run can only be increased by applying more

units of the variable factors to the fixed factors.

Average product (AP) is the output that is produced, on average, by

each unit of the variable factor. AP 5 TP ___ V , where TP is the total output

produced and V is the number of units of the variable factor employed.

Marginal product (MP) is the extra output that is produced by using

an extra unit of the variable factor. MP 5 ∆TP ____ ∆V

, where ∆TP is the

change in total output and ∆V is the change in the number of units of

the variable factor employed.

Take an example. A firm has four machines (fixed factors) and

increases its output by using more operators to work the machines.

Production figures for each week are given in Table 6.1.

Assessment advice:

In HL paper 3, you may be asked to calculate total, average, and marginal

product from a set of data and/or diagrams.

Table 6.1 Total, average, and marginal product per week

12

34

Quantity of

labour (V)

Total product (TP)

Average

product (AP)Marginal

product (MP)

00 10

110 10

15

225 12.5

20

345 15

25

470 17.5

20

590 18

15

6 105 17.510

7 115 16.435

8 120 15

As we add an

additional unit

of labour, more

output (TP) is

produced

The extra units

of output that are

produced when each

unit of labour

is added

The length of the short run for a firm will be determined by the time

it takes to increase the quantity of the fixed factor. This will vary

from industry to industry. For example, a small firm involved in

gardening may find that its fixed factor is the number of lawn

mowers that it has available and that it takes a week to order and get

delivery of a new lawn mower. Thus its short run is one week. On

the other hand, a national electricity provider is constrained by its

fixed factor, the number of electricity generating plants that it has.

Building a new electricity generating plant may take up to two years

(more if a nuclear plant is built) and so its short run is a lot longer.

If a firm plans ahead to change its fixed factors then all factors of

production are variable as the plans are being made. The firm is

planning in the long run. However, as soon as the fixed factors are

changed the firm is once again in the short run; it simply has a

different number of fixed factors. Once again, the only way that

output can be increased is to apply more units of the variable factors

to the new quantity of the fixed factors. As we said earlier, all

production takes place in the short run and all planning takes place

in the long run.

The following short section provides you with some important

definitions and equations. They may initially seem puzzling, but

will become clearer when used in an example.

Student workpoint 6.1

Be knowledgeable

Improve your knowledge of the short run and the long run by

considering the following scenario.

A small firm sets up a plant making teddy bears. The firm has a small

production unit, two teddy bear making machines and two operators.

There is one manager, who owns the firm, and carries out all non-

production activities. There is also an unlimited amount of the materials

needed to make the teddy bears.

Answer the following questions.

1 What are the fixed factors?

2 What is the variable factor?

There is an increase in the demand for teddy bears and the firm decides

to satisfy this demand with the existing factors.

3 What will the firm do?

The increase in demand persists and so the firm now decides to expand

the production unit, bring in two extra machines and employ two more

workers.

4 The planning takes place in which time period?

5 What time period is the firm in once the changes to the plant have

taken place and the firm is producing again?

6 What are the fixed factors now?

13 ● The level of overall economic activity2

Mac

roec

onom

ics

166

13 ● The level of overall economic activity

167

2 Macroeconom

ics

In the recovery phase we see economic expansion, with GDP increasing at a rising rate. This is largely driven by an increase in what

is known as aggregate (total) demand in the economy, as households

and businesses are encouraged to spend more. To meet the increase in

demand by households firms increase their output and take on more

workers so that unemployment falls. The newly employed workers spend their incomes on new goods and services and so household spending increases even more. Just as increasing demand for a good or

service can result in an increase in its price, so can increasing aggregate

demand in an economy lead to an increase in average prices. Thus, as

an economy “booms” it is likely that inflationary pressure will build up

and the rate of growth of GDP will fall as the economy nears its potential output. Economic policy makers are likely to react by trying

to slow down the growth of the economy and this may cause a fall in

total demand. This is the beginning of the recession part of the cycle.A recession is defined as two consecutive quarters of negative GDP growth, that is, falling GDP. (Please note that a decrease in GDP, where the economy actually gets smaller, is not the same as a decrease in GDP growth, which is where the economy continues to

grow, but at a slower rate.) During a recession, falling aggregate demand will lead firms to lay off workers, so unemployment rises. If

more people are unemployed, there will be even less spending. Low

levels of demand result in lower rates of inflation, or even deflation.At some point the contraction will come to an end. This is known as the trough. Output cannot continue to fall for ever as there will always

be some people with jobs to maintain a given level of consumption, foreigners will demand exports, governments will continue to spend by

running budget deficits, and people will be able to use savings to finance their consumption. Additionally, the low demand for money

for investment will result in lower interest rates. Thus, aggregate demand will pick up, the economy will enter the recovery phase, and

the cycle will repeat itself.As the diagram shows, the second recovery is at a higher level of real

GDP than the first and each boom is higher than the last. This illustrates the important point that economies tend to go through periodic fluctuations in real GDP around their long-term growth trend, or long-term potential output. This is shown in Figure 13.4.The periodic fluctuations in growth are shown as the actual output line,

while the economy’s long-term trend is shown as a steady increase in

output. This represents the growth rate that the economy can sustain

over time (but is not to be confused with sustainable development!). The difference between actual output and potential output is known as

the output gap. At point A there is a negative output gap. The economy

is producing below its trend and unemployment is likely to be a problem. At point B there is a positive output gap. The economy is producing above its trend, i.e. beyond capacity, and inflation is likely to

be a problem. This illustrates an interesting feature of economics. In the

short run it is quite possible that economies will face a “trade-off” between inflation and unemployment. When operating below trend unemployment will be a problem, while operating above potential will

result in inflationary pressure (rising rate of inflation). This will be addressed in greater detail later.

The business cycleIn developed country economies we can generally see a pattern where there are periods of rising growth, followed by periods of slowing growth and even falling growth. This is known as the business cycle or trade cycle. The business cycle is the periodic fluctuations in economic activity measured by changes in real GDP.

The phases of the business cycle are known as boom, recession, trough, and recovery. While the fluctuations are, in practice, highly

irregular, the most common illustration of the business cycle shows a

standard periodic cycle. This is illustrated in Figure 13.3.

Figure 13.3 The standard business cycle

0

Time

Boom

Recession

TroughRecovery

Contraction Expansion

Real

GD

P

Figure 13.4 Long-term trend and output gaps

0

Time

Real

GD

P

A

B

Long-termtrend

Actualoutput

Student workpoint 13.3Be a thinkerRead the following extract concerning the oil spill in the Gulf of Mexico in 2010. How does the issue highlight

the importance of valuing natural resources in national income accounts?

Referring to the BP oil spill, the U.N. urges new resource accountingLONDON, July 13 (Reuters) - The Gulf of Mexico oil spill highlights the need for governments to include the value of natural resources, such as fisheries, when calculating the size of their economies, the United Nations environment chief said.A U.N. Environment Programme report on Tuesday urged businesses to take more account of their impact on the natural resources which people depend on. It said the private sector would act faster if governments more explicitly

valued such resources, including biodiversity, a term for the wide array of animal and plant species.“The oil spill goes to the heart of a contradictory set of signals,” said the UNEP executive director. He said that the money spent on cleaning up the spill from BP Plc’s ruptured well in the Gulf of Mexico would be included in gross domestic product, the conventional measure of economic activity, but many costs to nature, including the health of fisheries and the survival of marine creatures, would not. “An oil spill

could turn out to be a positive thing for the GDP indicator, while it has actually caused a far greater (negative) impact in terms of the natural wealth and natural capital of the United States.”

IB Course Companion: Economics 2nd edition

HL material is integrated, so you can seamlessly challenge all your pupils

Exercises, activities, statistics and case studies are fully up-to-date and use examples students can relate to, helping them connect learning with the wider world

Exam questions are in every chapter, to ensure pupils are fully prepared for the external assessment

Uniquely developed in partnership with

the IB, so you can be confident it takes the

right approach.

2nd edition

TOK is integrated, making it easier for you to foster crucial critical thinking skills in an Economics context.

a brand new CD-ROM is loaded with extra material to further stretch your students. Flip over to find out more.

Plus

Assessment advice is included in every chapter, to help students achieve the best possible results

Plenty of charts and diagrams are integrated, to explain concepts visually and ease understanding

IB Course Companion: Economics 2nd edition

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The new Course Companion – what’s on the CD?

Comprehensive revision and skills development

Also new from Oxford, the 2nd edition of our Economics Study Guide, fully updated to match the new syllabus and thoroughly covering all the key concepts including the quantitative element. Plus, a brand new Skills and Practice text that will help your students strengthen the skills they need to successfully tackle the IB Economics exam.

Go online to find out more: www.oxfordsecondary.co.uk/ib.

Interactive diagrams on some of the most challenging topics – to help you solidify comprehension

Revision sheets to help students fully comprehend the most important ideas

Full glossary to support your EAL students, plus a glossary of diagrams to use on the whiteboard

Specimen exam papers to ensure students are really prepared for the external assessment

Brand new companion CD-ROM

Brand new companion CD-ROM

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